All information below is based on the current guidance (as 4/24/2020) provided by the Small Business Administration (SBA), CARES Act, and Internal Revenue Service (IRS).. Please remember that additional guidance can be provided at any time by the SBA or IRS and therefore please do not rely solely on this page. Please contact Isler CPA for the most up to date guidance.

During the last weeks, as well as the next few weeks ahead, businesses have or will have received their Payroll Protection Program loans (commonly known as the PPP). As businesses receive the funding for their loans, their attention should turn to understanding the requirements for loan forgiveness as provided by the PPP. This article will examine the calculations of the loan forgiveness, the terminology used to gather information required for the loan forgiveness, and the three tests or hurdles that must be cleared in order to have 100% of the loan forgiven.


Understanding Terminology

  • Covered Period:  The eight week period beginning on the date the loan is funded or funds are received from the lender.
  • Payroll costs:  Payroll Costs include the following:
    • Employer Payroll Costs
      • Gross salary, wages, commissions, or similar compensation
      • Cash tips or equivalent (based on employer records of past tips or, in absence of such records, a reasonable, good-faith employer estimate of such tips)
      • Payments for vacation, parental, family, medical, or sick leave (excludes wages creditable under the Family first Coronavirus Response Act).
      • Payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums
      • Payments for retirement benefits
      • Payments of state and local tax assessed on compensation of the employees.
    • Sole Proprietor / Independent Contractors:
      • Gross salary, wages, commissions, or similar compensation paid to employees
      • Net earnings from self-employment (Generally what would be reported line 31 of your Form 1040 Schedule C) up to $100,000 annualized
      • In addition, the SBA has clarified that self-employment income generated from a partnership should be included in the payroll costs of the partnership (up to $100,000 per partner)
    • Excluded Payroll Costs:
      • Any compensation of an employee whose principal place of residence is outside the United States
      • Payments to independent contractors reported on a Form 1099 (Such contractors can apply for their own PPP loan)
      • Compensation of an individual employee in excess of an annual salary of $100,000, prorated as necessary
      • Employer portion of federal payroll taxes such as Social Security, Medicare, and Federal Unemployment taxes
  • Mortgage obligation:
    • Payments for mortgage interest during the covered period on a mortgage obligation incurred before February 15th, 2020
    • Payments for interest on any other debit incurred for business purposes before February 15th, 2020
  • Rent obligation:  Payments made on rent obligations on leases dated before February 15th, 2020
  • Utilities:  Payments made for electricity, gas, water, telephone, or internet access


Understanding Eligible Amount of Loan Forgiveness

  • The maximum eligible amount of the loan forgiven is the sum of the costs/payments made for items described above in the terminology section (payroll costs, interest payments on covered mortgages, covered rent obligations, and covered utility payments).


Understanding Potential Reductions to the Eligible Amount of the Loan Forgiveness

  • There are three tests/requirements that, if not satisfied, can reduce the amount of the eligible loan forgiveness. The tests are as follows:
    • Test 1 – Overall Expenditures:
      • The SBA requires that not more than 25% of the proceeds, received from the PPP, can be spent on covered non-payroll costs. If more than 25% of the proceeds are spent on covered non-payroll costs, then none of the loan is forgivable.

Just because a borrower meets Test 1 above, doesn’t mean that 100% of the PPP loan will be forgiven. The eligible amount of loan forgiveness can be reduced by the following tests:

    • Test 2 – Full Time Equivalent Test (FTE)
      • The amount of eligible loan forgiveness may be reduced if there has been a reduction in full-time equivalent employees. This reduction is calculated by multiplying the amount of loan forgiveness by a fraction. The numerator is the average number of full-time equivalent employees of the borrower during the eight-week covered period. The denominator is either (historical FTEs):
        • (a) the average number of full-time equivalent employees of the borrower between Feb. 15, 2019 and June 20, 2019, or
        • (b) the average number of full-time equivalent employees of the borrower between Jan. 1, 2020 and Feb. 29, 2020
        • Note – borrows are allowed to use (a) or (b) for this test (whichever is more favorable).
      • Example:
        • Assume a borrower has $15,000 of eligible loan forgiveness and has an average FTE for the covered period of 10 employees, as compared to 12 FTEs in testing periods (a) or (b) above. Therefore, the eligible amount of the loan forgiveness would be reduced to $12,500 {$15,0000 * (10 / 12 ) = $12,500}.
      • An item to note, and which we are getting questions about, is how FTE are calculated for PPP purposes. Up to this point the SBA has not issued guidance around this calculation.
    • Test 3 – Wage Reduction
      • Generally, the eligible amount of loan forgiveness is further reduced if an employee, who made less than $100,000 in annualized wages in 2019, receives a reduction in pay of more than 25% during the covered period compared to what the employee’s wages were for Q1 of 2020 (for most employees). In other words, during the covered period, the employee’s wages must at least 75% of wages received during Q1 of 2020.
      • This is calculated on an employee by employee basis. If this test is not satisfied for an employee, the eligible amount of loan forgiveness is reduced dollar or dollar for the amount of reduction in wages in excess of 25%.
      • Example:
        • Assume an employee’s wages were $6,000 during Q1 of 2020 but were reduced during the covered period to $3,600. Because the wages received during the covered period were 60% ($3,600 / $6,000) of his or her wages during Q1 of 2020, the eligible amount of loan forgiveness will be reduced. The test required that the employee earn at least $4,500 ($6,000 * 75%) during the covered period. The eligible amount of loan forgiveness will be reduced by the difference between what the employee should have earned ($4,500) and what she or he did earn ($3,600), for a reduction of $900.

If for some reason a borrower doesn’t meet the requirements for Test 2 or Test 3, the program allows the borrower to rectify the situation by June 30, 2020. Unfortunately, at this time the SBA has not provided guidance on the mechanics on how this is to be accomplished.


Understanding Required Documentation

  • In order to apply for the loan forgiveness (through the original lender) borrowers will need to submit the following documentation:
    • Documentation to verify the number of FTEs and documentation for pay rates including payroll tax filings submitted to the IRS, state payroll filings, and unemployment insurance filings.
    • Documentation including cancelled checks, payment receipt, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments.
    • Certification that documentation presented is true and correct and the amount of forgiveness requested was used to retain employees, make interest payments on covered mortgage obligations, make payment on covered rent obligations, or make covered utility payments.
  • In addition, the SBA issued guidance on 4/23/2020 stating that businesses must be prepared to demonstrate to the SBA, upon request, the basis for the company’s certification that the company needed the PPP loan to support its ongoing operations.
    • The SBA did not provide guidance on what the support should look like; however, one suggestion for documentation to support the need for the PPP loan is a projected or forecasted cash flow for the next 3, 6 and 12 months. If a projection of cash flows has not been prepared it is recommended that one be prepared quickly.
    • In addition, documentation of lack of funding (i.e., lack of the business’ ability to acquire other funding such as a loan or line of credit would be helpful documentation.
    • If a business can’t support or provide basis for the PPP loan, the business can repay it to the SBA by May 7th, 2020 and not suffer any consequences.


If you have further questions around the Payroll Protection Program please contact your CPA.

The information and tips noted above are intended as general guidelines only. The provisions within the CARES Act are complicated, with many questions still unanswered. Every client’s situation is unique and the ideas expressed in this article should not be considered a substitute for professional advice. Opinions expressed in this article are subject to change as interpretations are clarified and additional guidance is issued. Please call our office if you have questions regarding the CARES Act or any other recent legislation.